Should you join the crowd? The definitive answer is . . . maybe, but then again, maybe not. These policies carry unusual risks. But for venturesome buyers, impatient with the low interest rates other types of policies pay, VULs shine like hope.
To save you time, let me tell you who should turn the page. VULs aren’t for families who need a lot of coverage, cheap. Their best buy is term insurance, which delivers death protection at a low out-of-pocket cost.
A VUL requires higher premiums, part of which pay for death protection and part of which go into what amounts to an investment fund. It’s for buyers who (1) can afford full protection for their families and can put extra money aside, (2) will keep the policy for 15 years or more (preferably for life) and (3) would rather invest in life insurance than something else. This usually means higher-income people dazzled by the fact that life-insurance savings can accumulate tax-deferred.
The word ““universal’’ in VUL’s name means ““flexible.’’ You can vary the size of the premiums you pay and change the policy’s death benefit.
But the ““variable’’ is what really rings the buyers’ bells. With other types of insurance, your cash goes primarily into bonds. With VUL, you can choose among mutual funds, including funds invested in stock. This could give you higher returns if you hold the policy into your retirement years.
You can also play tax tricks that other deferred-savings products don’t allow. Like taking money out of the policy and paying no tax until you’ve withdrawn all the cash you put in. And borrowing against your cash value, often at a low interest rate. Structured loans and withdrawals can yield a regular tax-free income. When you die, the remains of your policy (minus the sums you’ve used up) can pass to your beneficiary tax free.
So what’s not to like? On paper, nothing. But I’m always mindful of Murphy’s Law (if anything can go wrong it will) and of Quinn’s Corollary (Murphy was an optimist). Some caveats:
Most VULs carry higher expenses than other types of policies. You pay more for the VUL itself and more for investment management. On one typical contract, a 9 percent return netted down to 2.5 percent after 10 years (due largely to sales charges) and 6 percent after 20 years, including the value of the insurance. Buyers should plan to put all their money into the policy’s stock-owning funds, says life-insurance consultant Peter Katt of West Bloomfield, Mich. Stocks have a better chance than bonds of yielding a decent return after costs.
Your results depend on how well the market performs year by year, which few investors realize. For example, say you expect your stocks to yield 9 percent annually, but late in the program the market does badly for three years. Your policy’s costs will then be drawn from diminishing assets. You might have to add a slug of money to keep the coverage intact – even if your stocks yield 9 percent in the long run, says Paul Kelley of Columbine Insurance Consulting in Salt Lake City. So buy a VUL only if you have surplus income. You might also arrange to guarantee your death benefit, even if your investments do poorly.
A second example. Based on the returns from stocks and bonds from 1973 to 1992, an all-stock VUL would have outperformed regular universal life (assuming its returns matched those of bonds), Katt says. But what if those annual returns had run in reverse order? Then the regular policy would have won. Stocks raise your odds, but they’re no guarantee.
Life insurance wasn’t intended to be a tax dodge for the rich. Someday Congress may shut the loophole that gives you a tax-free retirement income – and don’t count on being grandfathered, warns Glenn Daily, a New York life-insurance consultant.
Many buyers are leaving their policies dangerously underfunded. For example, you might be allowed a premium as high as $4,000 a year but have only $2,000 to spend. If you pay just $2,000, however, and your stocks underperform, you’ll have to add money (or reduce the death benefit) to keep your coverage from lapsing. Best bet, says Chris Kite of Fipsco in Des Plaines, Ill., which designs software for sale illustrations: choose a policy that you can fund at close to the maximum allowed. Deliberately paying high premiums goes against the grain, but it leverages your investment and raises the odds that your coverage will stay in force. Opt for a rising death benefit, to get higher payouts in the future.
A risk for those who plan to borrow is that you’ll take too large a loan. Even a ““reasonable’’ loan might loom large, if the policy’s stock investments crash. If you can’t repay (which might be hard when you’re retired), your policy could lapse – causing all the loans in excess of the premiums you paid to be taxed as personal income. To avoid this disaster, Kite advises that you limit your loans to 70 percent of the cash value.
Around 30 companies now sell VUL, led by Prudential and Equitable Life. The list includes two low-load companies, which charge no upfront sales commissions: Security Benefit Life and American Life of New York. But both levy higher annual fees than many agent-sold policies do. Their rate of return exceeds Equitable’s over 10 years, according to one analysis by actuary James Hunt of the National Insurance Consumer Organization. Over 20 years, however, Equitable catches up with American Life. Security Benefit keeps its lead on policies of $250,000 and less but not on $500,000 policies. For long-term investors, the size of the fee clearly matters more than sales charges.
The low-load crowd is waiting for a VUL due in February from Ameritas Life in Lincoln, Neb., which will offer no-load funds managed by the Vanguard Group and Neuberger & Berman. It’s believed to have the lowest costs and competitive returns. So the range of products is expanding, for those who don’t mind owning life insurance that carries risk.
